Sticking With Bonds

Financial advisor Scott Siegel of JPMorgan Securities likes to go against the grain. As investors move back into stocks, he's finding some good opportunities in the fixed-income arena -- especially in high-yield bonds.

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Pay no attention to the technology on his desk: There's an old-school feel to Scott Siegel, and it's best captured by the low-tech whiteboard that dominates a wall in his office at J.P. Morgan Securities. Felt-tip scribblings show all of his team's bond holdings, along with the other fixed-income investments the seven-person group is watching. It's not just a quaint accoutrement -- it's a clear sign of Siegel's thoughtful, deliberate stewardship of his bond holdings at a time when most financial advisors are relying on outside managers to run fixed-income portfolios.

His team researches, buys and sells individual bonds, a strategy that has definite appeal to some high-net-worth investors. "Our clients are not asking us to go and meet with them and play golf; they really want us behind the desk," Siegel says. For the last three years, Siegel has appeared on Barron's list of Top 100 financial advisors. In 2012, he ranked 98th.

Siegel is by no means bonds-only; his typical account is about 45% stocks, 40% bonds, and 15% cash. But he's the unusual financial advisor who wants to talk up bonds even in a market that's suddenly very focused on stocks—2013 is shaping up to be the first in five years that investors have put more into stock funds than they have into bond funds, according to Lipper.

Siegel is taking a cautious approach to what some are calling a Great Rotation—a much-anticipated move by investors from bonds to stock. "I think it's a move being forced by the Fed," Siegel says. "What I see are people with a risk tolerance that's not particularly high being forced to take on more risk to generate return, to maintain a lifestyle."

"Everyone is saying 'sell fixed income'," Siegel says. "We're using the noise that's out there as an opportunity to acquire more securities." He thinks high-yield debt is the best among some admittedly pretty bad options in the fixed-income world. But for investors looking for income, the sector's average yield of 6%, though the lowest it's ever been, still isn't too shabby, and Siegel hunts for short-term issues that he can hold onto until maturity.

THE 50-YEAR-OLD ADVISOR'S expertise dates back to his first job, with a New Jersey bond house called Liss, Tenner, & Goldberg. He joined in 1984, right after graduating from the University of Maryland. In 1998, Siegel joined Bear Stearns and stuck with the firm through its collapse and acquisition by JPMorganChase in 2008.

Siegel points out that some of the same factors driving investors toward stocks—strong earnings, solid balance sheets—make high-yield bonds more attractive. Since 2008, companies "have right-scaled themselves," Siegel says. "They've cut back on employees, moved out their debt maturities, cut down on inventories, and done a lot of things to shore up their balance sheets. It makes perfect sense from a bondholder's standpoint, but it's not quite as attractive from an equity standpoint."

That's because stocks require a macro catalyst, he says. "How do you get that exponential growth from these companies going forward unless you see a real pickup in the economy? I'm not necessarily sure that's there." His group tends to focus on dividend and value stocks. Meanwhile, thanks to Corporate America's strong balance sheets, default rates for high-yield bonds are now just 2%, down from a historical average of about 5%, according to Fitch Ratings. (Even in default, recovery rates are still 50% of the bond's par value.) A bigger risk, Siegel acknowledges, is in bonds' getting "called," meaning the company repays its debt in full before maturity. Investors don't lose any principal, just the future yield. But Siegel thinks if that happens, there will be other options for him to redeploy the cash. He expects high-yield bonds to generate 5% to 7% in income in the coming years, close to the historical return provided by the Standard & Poor's 500, but with far less volatility along the way.

Siegel's compliance department wouldn't allow him to discuss specific securities, but he's finding the most opportunity in a few industries, in particular, energy, commodities, and health care.

To guard against an eventual rise in interest rates, Siegel has reined in the maturity dates of his bonds; they range from five to eight years now, down from as much as 30 in recent years. He's eliminated any exposure to Treasuries. And, while he's historically been a big buyer of municipal bonds, Siegel thinks they're too expensive right now: "I just don't think the returns at these levels are representative of the credit."

There are still values to be found in corporate bonds, though. And Siegel, ever the contrarian, will keep adding names to that big board in his office.